Proxy Season Shakedown: A New Wave of Suits Challenging Compensation Disclosures

The Second Wave of Say-on-Pay
With the prospect of a quick settlement in derivative say-on-pay lawsuits diminishing, plaintiffs’ firms have adopted a new litigation approach: threatening to enjoin a shareholder meeting by challenging the adequacy of a company’s compensation-related disclosures in its proxy statement. In the last year, over 20 class-action lawsuits (most of which have been filed by the same plaintiffs’ law firm, Faruqi & Faruqi) have been filed against companies and their directors seeking to enjoin the annual shareholder meeting (i.e., before the say-on-pay vote). The gravamen of these lawsuits is that the proxy statement failed to disclose all material information related to (1) the say-on-pay vote and/or (2) any other compensation-related proposal, such as amendments to an equity plan. Like the first wave of say-on-pay litigation, these lawsuits allege breaches of fiduciary duty by the company’s directors. However, because they are class actions and not derivative suits, plaintiffs do not first need to make a demand on the company’s board or adequately allege demand futility in order to proceed with their claims. Therefore, these cases avoid the primary obstacle that impeded the prior wave of say-on-pay litigation.

Given that most of these lawsuits are filed by the same firm, the allegations are very similar across the board and derived from the disclosure claims often asserted in M&A litigation. As to the say-on-pay vote, plaintiffs usually allege that the following information is material and should be disclosed in the proxy statement:

• How and why the board or compensation committee retained an independent compensation consultant
• The amount of fees paid to the compensation consultant
• A “fair summary” of the compensation consultant’s analysis
• The reasons why the board or compensation committee opted for a particular mix of salary, cash incentive, and equity incentive compensation
• Details regarding the metrics associated with the peer group analyses

As for other compensation proposals, such as amendments to an equity plan, plaintiffs typically allege that the following information is material and should be disclosed in the proxy statement:

• The projected number of shares to be awarded during the current year (and subsequent years) under the company’s equity incentive plan
• How the board determined the number of additional shares requested to be authorized
• The dilutive impact that issuing additional shares may have on existing shareholders
• The potential equity value and/or cost of the issuance of additional shares
• A summary of any expert analysis provided to the company’s board in connection with the proposal

Like the M&A strike suits, the plaintiffs (and their lawyers) hope to create enough uncertainty about whether the company can proceed as scheduled with its annual shareholder meeting so that the company will settle by agreeing to provide additional disclosures and paying an attorney-fee award to the plaintiffs’ counsel. To induce companies to settle quickly, plaintiffs routinely file a motion for preliminary injunction or temporary restraining order, asking the court to postpone the shareholder meeting until additional disclosures are made in the proxy statement. If plaintiffs obtain a preliminary injunction and the court orders the company to make additional disclosures in the proxy, then the plaintiffs’ counsel will submit an application to the court for an attorney-fee award, under the theory that it secured a material benefit for the shareholders. In fact, even if the company voluntarily amends its proxy statement and discloses the allegedly omitted information, thereby mooting the plaintiffs’ claims, the plaintiffs’ counsel will likely still submit an application to the court for an award of attorney fees, arguing that the lawsuit caused the company to make the additional disclosures.

Even though most of the companies that have been on the receiving end of these class-action lawsuits are incorporated in Delaware, which means that Delaware law applies, plaintiffs have not been filing these actions in Delaware. Instead, they have filed in state court where the company has its principal place of business. Presumably, plaintiffs believe that, in front of a judge who is not well-versed in Delaware law, there is greater uncertainty and they have a greater likelihood of prevailing on a motion for preliminary injunction. The practical effect of plaintiffs’ forum selection is to impede the development of binding Delaware case law regarding the materiality of information and adequacy of disclosures, which would both increase the consistency of outcomes (allowing companies to better assess the risk of fighting the lawsuits) and help companies understand the scope of information that must be disclosed. Several defendants have removed these actions to federal court, but in each case in which the plaintiff moved for remand, the district court judge granted the motion and sent the action back to state court. Hutt v. Martha Stewart Living Omnimedia Inc., No. 12-cv-03414 (S.D.N.Y.); Rice v. Ultratech, Inc., No. 12-cv-05722-SBA (N.D. Cal.); Boxer v. Accuray, Inc., No. 12-cv-01006 (N.D. Cal.).

These proxy class actions, like their merger-litigation cousins, create a dilemma for the defendant companies trying to assess the risks and benefits of settlement. Should the company opt for quick resolution by settling the lawsuit, agreeing to provide certain supplemental disclosures, and paying attorney fees to the plaintiffs’ counsel? Or should it vigorously defend the lawsuit, risking a possible injunction, postponement of the shareholder meeting, and a potentially larger payment of attorney fees? The risk-benefit analysis is further complicated by the inherent difficulty in predicting how courts will view the merits of these lawsuits, particularly where, as here, only a handful have reached a resolution on a preliminary injunction motion.

The good news for defendants is that, so far, the results have not been particularly favorable for plaintiffs. Although a number of companies have opted to settle these cases (with an associated range of attorney-fee awards of $125,000 to $450,000), we are aware of only two cases in which the plaintiff has successfully obtained a preliminary injunction. Knee v. Brocade Comm. Sys., Inc., No. 1-12-cv-220249 (Cal. Super. Ct. Santa Clara Cnty., filed Mar. 7, 2012); St. Louis Police Ret. Sys. v. Severson, No. 12-cv-5086-YGR (N.D. Cal., filed Oct. 1, 2012). Further, in late 2012, several companies (AAR Corp., Clorox, Globecomm Systems, and Hain Celestial Group) opted to fight and successfully opposed a motion for preliminary injunction. Noble v. AAR Corp., No. 12-c-7973 (N.D. Ill.); Mancuso v. The Clorox Co., No. RG12651653 (Cal. Super. Ct. Alameda Cnty.); Wenz v. Globecomm Sys., Inc., No. 031747/2012 (N.Y. Sup. Ct. Suffolk Cnty.); Morrison v. The Hain Celestial Group, Inc., No. 602074/2012 (N.Y. Sup. Ct. Nassau Cnty.). In denying the motions, these judges have generally followed a similar rationale: recognizing that the say-on-pay vote is advisory and, as a result, neither the plaintiff nor the shareholder class will suffer irreparable harm if the court refuses to enjoin the shareholder meeting.

As companies enter the 2013 proxy season, we expect more of these shareholder class actions to be filed by Faruqi & Faruqi, but it is unclear how many, how often, and whether other plaintiffs’ firms will enter the fray. As a result, most, if not all, public companies face some litigation risk. Although there is no guarantee that amplifying proxy statement disclosures will prevent one of these suits, companies should, in addition to ensuring that their proxy statements comply with applicable securities laws, consider enhanced disclosures (particularly regarding say-on-pay and stock plan share reserve proposals) and consult their legal advisors.

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